Life insurance plays a vital role in many estate plans. It provides salary replacement for a family if a heart attack or tragic car accident takes the life of a breadwinner. These policies may also be a part of a business or ranch/farm succession plan.
Generally, life insurance death benefits pass without triggering Federal or Colorado state tax. One thing that most people do not consider is that these benefits can be added to the value of a taxable estate when they pass to someone other than a spouse.
Federal exemption is generous, but may not be enough
In 2017, the federal estate tax exemption is approximately $10.9 million for a married couple ($5.4 million for an individual). In a blog post last month, we discussed the portability of any unused portion of the exclusion between spouses. Remember it is necessary to file a request, because this does happen automatically.
While these numbers are generous, if you have a business with a valuation in the millions or a ranch with hundreds of acres, your estate valuation could become an issue. In these cases, life insurance policies that list children or other relatives as beneficiaries must be carefully considered or they could add to the value of your taxable estate.
Irrevocable life insurance trust
A trust can be created to own the life insurance policy or policies. The trust must be funded with assets that will cover premiums. Death benefits would then go to whomever is names a beneficiary of the trust. This bypasses your estate and can eliminate the risk that death benefits push the value of your estate over the exemption threshold.
Setting up this type of trust is not a DIY project. And transfers of an existing policy can cause issues related to timing of the transfer. For example, if you die within three years of transferring an existing policy, the death benefits are still added to the value of your taxable estate.
Without a comprehensive estate planning conversation, it becomes more likely that mistakes can leave a mess for heirs. Get individualized guidance based on your financial situation today.